Tax Loopholes and Credits Cost Billions. Voters Need to Understand Them

If you think of the tax system as a big bucket used to collect money for programs and infrastructure, you’re wrong.

Successive governments have drilled it with so many holes that it looks more like a sieve.

When The Tyee asked readers to help direct our election coverage, you asked for a deep look at issues of tax fairness and inequality.

We boiled it down to this question: “What are the tax loopholes in Canada, how have other countries closed them, what are candidates willing to do to assure the rich pay their fair share and reverse the widening wealth gap?”

There are a lot of loopholes. Consider this piece a primer on tax loopholes, how they work and who benefits. We’ll take a look at the parties’ positions and other options in subsequent reports.

Budget documents list hundreds of “tax expenditures” or loopholes, potential revenue that the government has chosen to forego for one reason or another.

In general, these are legal ways individuals and corporations can reduce the amount of tax they pay. Many are widely used and well-supported, but a significant number give an unfair advantage to people who already have more money.

“I think the general public feels that if others can take advantage of these measures that they can’t... that the tax system isn’t fair,” said Toby Sanger, the director of Canadians for Tax Fairness. “A major way the tax system could be made more fair is to get rid of the regressive loopholes that are in it.”

The organization has released a 14-page platform that it says will “restore equality, strengthen the economy and invest in quality public services.” It includes calls to close several regressive tax loopholes — ones that shift the cost of government onto those who can least afford to pay.

Take, for instance, the rule that allows businesspeople and companies to deduct some of the cost of meals and entertainment from their income. Only about two per cent of Canadians make such a claim each year, and yet this year the practice will cost the public $740 million.

Another loophole in the government’s list of tax expenditures is the “deduction of interest and carrying charges incurred to earn investment income.” The idea is to avoid taxing some of the money investors may spend to make money. It’s a deduction that about one out of 75 Canadians use, but costs the government $1.8 billion a year in revenue.

An even bigger budget hole comes from the tax exemption for capital gains on principal residences. The government’s budget documents describe the rationale: “This measure recognizes that principal homes are generally purchased to provide basic shelter and not as an investment.” The policy allows families to move from one home to another as their circumstances change, the documents say.

While that might sound like a worthy goal, anyone living in Vancouver or Toronto as real estate prices have soared have seen people buy a property, live in it briefly, then flip it for a much higher price, paying no tax on the profit.

The government doesn’t have data on how many people use the tax break, which clearly benefits people already well off enough to own a home. But it estimates the cost to the public at $6 billion a year — enough money to increase health spending by more than 15 per cent. It’s been in place since 1972 and viewed as sacred by many.

Alex Hemingway, an economist and public policy analyst in the B.C. office of the Canadian Centre for Policy Alternatives, said as well as costing the government money, the policy drives up the cost of homes and discourages developers from building rental housing.

The CCPA has proposed a $500,000 lifetime cap on tax-free capital gains from the sale of primary residences. That would “keep things within reason a little more,” said Hemingway.

The public also rewards people affluent enough to buy homes with $110 million through the First-Time Home Buyers’ Tax Credit.

Then there’s the employee stock option deduction, which “to support competitiveness” allows people to pay less tax on income that comes in the form of shares in the company work for. That primarily benefits high-income senior executives in big corporations.

In 2016 about 34,000 people — one out of every 1,000 Canadians — claimed the deduction. This year it will cost the public about $685 million — an average $20,000 tax break for the people who benefit.

And then there’s the policy of only taxing 50 per cent of capital gains, such as profits from selling stocks that have gained in value, as income. That costs the public almost $17 billion each year. Only 10 per cent of Canadians — again mostly affluent — benefit.

Hemingway said it’s unfair to tax only half of capital gains while people pay tax on all of the income they earn by working. “I think it’s right to call that a loophole... and the benefits of it go overwhelmingly to the top decile of income earners.”

Some deductions are aimed at encouraging businesses, including by providing incentives for research or other activities:

• $5.6 billion for the preferential tax rate for small businesses;
• $3.7 billion for the Accelerated Investment Incentive;
• $4 billion for the Scientific Research and Experimental Development Investment Tax Credit;
• $6.7 billion for exemptions from non-residents withholding tax;
• $7.4 billion for non-capital loss carry-overs;
• $5.3 billion for the dividend gross-up and tax credit.

Some are supposed to encourage particular industries, including those exploiting natural resources:

• $330 million for the Canadian Film or Video Production Tax Credit;
• $295 million for the Film or Video Production Services Tax Credit;
• $150 million to flow-through share deductions for investors in the oil and gas, mining and renewable energy sectors;
• $65 million for a Mineral Exploration Tax Credit for flow-through share investors;
• $25 million for the Corporate Mineral Exploration and Development Tax Credit;
• $20 million as an exemption from branch tax for transportation, communications and iron ore mining corporations;
• $61 million for the Logging Tax Credit.

Or to benefit people and companies in particular regions:

• $180 million for the Atlantic Investment Tax Credit;
• $235 million for Northern Residents Deductions.

Sanger traces the opening of many of the loopholes to the Liberal government in the early 2000s. “There was a real shift at that time,” he said. New measures like reducing the tax rate on capital gains and stock options were intended to encourage savings and investment.

“This multibillion-dollar experiment hasn’t worked in this way,” he said. Business investment has instead declined, and many Canadians have been hurt. “We’ve had a big increase in inequality, in inequality of wealth, in corporate profits and surpluses.”

Other benefits from tax credits or deductions are used by more people, but not large enough to offset the big tax losses from loopholes available to high-income earners. The basic personal exemption adds up to $37 billion a year, the charitable donation tax credit to $3 billion, and the exemption of basic groceries from GST to $4.9 billion.

There’s $2.4 billion for the Canada Employment Credit, $1 billion for other employment expenses and $2.1 billion for the Canada Workers Benefit. We pay $120 million a year to help people with moving expenses when they move closer to a new job or to go to school.

Pension income splitting costs the public $1.4 billion in lost tax revenue a year. There are also large amounts from not taxing the money used for pension or RRSP contributions.

The income that doesn’t get taxed because it is inside tax-free savings accounts costs the government $1.2 billion a year. While more than one-third of Canadians have TFSAs, it’s a safe bet the country’s wealthiest people are making maximum contributions and seeing maximum tax reductions.

Allowing Canadians who leave the country to bring home a certain amount of goods duty-free costs $310 million a year.

A significant amount goes towards helping families who are raising children, right through their post-secondary education:

• $24.2 billion for the Canada Child Benefit;
• $1.4 billion for the childcare expense deduction;
• $190 million to exempt childcare from GST;
• $165 million associated with Registered Education Savings Plans;
• $250 million for the Education Tax Credit, $40 million for the Textbook Tax Credit and $1.7 billion for the Tuition Tax Credit;
• $905 million for the exemption from GST for tuition and educational services;
• $405 million to exempt scholarship, fellowship and bursary income.

The “fairness” of some measures likely depends on perspective. No doubt the 26,500 individuals who benefit from the “deduction for clergy residence” which “recognizes the special nature of the contributions and circumstances of members of the clergy” think it’s fair. But people who aren’t religious might wonder why we’re putting a $100 million hole in the tax bucket for that.

Allowing the deduction of union or professional dues costs more than $1 billion.

There are various deductions available to former police officers, members of the Canadian Armed Forces and veterans, as well as several to help with people coping with disability or medical expenses.

For the overall view, the government provides a summary of how much personal income tax different taxpayers pay. The top one per cent of earners, people who make over $200,000 a year and who are most able to pay, provide nearly a quarter of the total. The bottom 31 per cent of taxpayers pay 12 per cent.

David Macdonald, a senior economist with the Canadian Centre for Policy Alternatives, examined Canada’s personal income tax expenditures for a 2016 report Out of the Shadows. He found that only five of them could be considered progressive, meaning that more than half of its benefits go to the lower half of income earners.

The five progressive expenditures were the working income tax benefit, the non-taxation of the guaranteed income supplement, the non-taxation of social assistance, the deduction for refundable medical expenses, and the disability tax credit.

The rest of the tax expenditures were regressive, he found, meaning that the top half of income earners saw more than half of the benefits.

When he looked at the five most regressive tax expenditures, they provided 99 per cent of their benefit to people in the top half of earners. They included pension income splitting, the dividend gross-up, the stock option deduction, the credit for the partial inclusion of capital gains and the foreign tax credit.

According to the government, the dividend gross-up “is generally meant to ensure that income earned by a corporation and paid out to an individual as a dividend will be subject to the same amount of tax as income earned directly by the individual.”

About one out of 10 Canadians claim the credit each year. The foreign tax credit gives residents of Canada credit for income tax they’ve already paid to a foreign government. The credit was claimed by about 1.4 million Canadians in 2016.

In 2011, the year Macdonald drew on for the report, the five loopholes added up to a $10.4-billion expenditure.

“As with all tax expenditures, these amounts reflect real money that is being spent based on fiscal choices made by the federal government,” he wrote. “Policy-makers should continue to examine tax expenditures through a broad income inequality or vertical equity lens, and to consider the totality of these expenditures as a grossly unfair shadow transfer system for Canada’s richest tax filers.”

In the current fiscal year, the federal government will collect a projected $282.9 billion in tax revenues. The bulk of that comes from personal income tax, corporate income tax and the GST.

Government budgets are about choices, and for politicians looking for ways to make Canada’s tax system fairer there are countless options. Some will be debated ahead of the federal election while others will be, wrongly, ignored.

The ignored will no doubt include the credit for political contributions, a credit claimed by only about one out of every 250 Canadians in an average year. This election year the credit is expected to cost the public $45 million. People tracking the campaigns will have to decide if that’s money well spent.

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